MARKET STRUCTURE

The interconnected characteristics of a market, such as the number and relative strength ofbuyers and sellers and degree of collusion among them, level and forms of competition,extent of product differentiation, and ease of entry into and exit from the marketFour basic types of market structure are (1) Perfect competition: many buyers and sellers,none being able to influence prices. (2) Oligopoly: several large sellers who have somecontrol over the prices. (3) Monopoly: single seller with considerable control over supply andprices. (4) Monopsony: single buyer with considerable control over demand and prices.

Types of market structures

I.Monopolistic competition, a type of imperfect competition such that many producerssell products that are differentiated from one another (e.g. by branding or quality) andhence are not perfect substitutes. In monopolistic competition, a firm takes the pricescharged by its rivals as given and ignores the impact of its own prices on the prices ofother firmsII.Oligopoly, in which a market is run by a small number of firms that together controlthe majority of the market share.III.Duopoly, a special case of an oligopoly with two firms.IV. Monopsony, when there is only a single buyer in a market.V. Oligopsony, a market where many sellers can be present but meet only a few buyers.VI.Monopoly, where there is only one provider of a product or service.a. Natural monopoly, a monopoly in which economies of scale cause efficiencyto increase continuously with the size of the firm. A firm is a natural monopolyif it is able to serve the entire market demand at a lower cost than anycombination of two or more smaller, more specialized firms.VII.Perfect competition, a theoretical market structure that features no barriers to entry, anunlimited number of producers and consumers, and a perfectly elastic demand curve.ELEMENTS AND CONCERNSThe imperfectly competitive structure is quite identical to the realistic market conditionswhere some monopolistic competitors, monopolists, oligopolists, and duopolists exist anddominate the market conditions. The elements of Market Structure include the number andsize distribution of firms, entry conditions, and the extent of differentiation.These somewhat abstract concerns tend to determine some but not all details of a specificconcrete market system where buyers and sellers actually meet and commit to trade.Competition is useful because it reveals actual customer demand and induces the seller(operator) to provide service quality levels and price levels that buyers (customers) want,typically subject to the sellers financial need to cover its costs. In other words, competitioncan align the sellers interests with the buyers interests and can cause the seller to reveal histrue costs and other private information. In the absence of perfect competition, three basicapproaches can be adopted to deal with problems related to the control of market power andan asymmetry between the government and the operator with respect to objectives and1

The correct sequence of the market structure from most to least competitive is perfectcompetition, imperfect competition, oligopoly, and pure monopoly.The main criteria by which one can distinguish between different market structures are: thenumber and size of producers and consumers in the market, the type of goods and servicesbeing traded, and the degree to which information can flow freely.

PERFECT COMPETITIONIn economic theory, perfect competition (sometimes called pure competition) describesmarkets such that no participants are large enough to have the market power to set the priceof a homogeneous product. Because the conditions for perfect competition are strict, there arefew if any perfectly competitive markets. Still, buyers and sellers in some auction-typemarkets, say for commodities or some financial assets, may approximate the concept. As aPareto efficient allocation of economic resources, perfect competition serves as a naturalbenchmark against which to contrast other market structures.

Basic structural characteristics

Generally, a perfectly competitive market exists when every participant is a "price taker", andno participant influences the price of the product it buys or sells. Specific characteristics mayinclude:1. A large number buyers and sellersa. A large number of consumers with the willingness and ability to buy theproduct at a certain price, and a large number of producers with thewillingness and ability to supply the product at a certain price.2. No barriers of entry and exit2

a. No entry and exit barriers makes it extremely easy to enter or exit a perfectlycompetitive market.3. Perfect factor mobilitya. In the long run factors of production are perfectly mobile, allowing free longterm adjustments to changing market conditions.4. Perfect informationa. All consumers and producers are assumed to have perfect knowledge of price,utility, quality and production methods of products.5. Zero transaction costsa. Buyers and sellers do not incur costs in making an exchange of goods in aperfectly competitive market.6. Profit maximizationa. Firms are assumed to sell where marginal costs meet marginal revenue, wherethe most profit is generated.7. Homogeneous productsa. The products are perfect substitutes for each other;i.e.-the qualities andcharacteristics of a market good or service do not vary between differentsuppliers.8. Non-increasing returns to scalea. The lack of increasing returns to scale (or economies of scale) ensures thatthere will always be a sufficient number of firms in the industry.9. Property rightsa. Well defined property rights determine what may be sold, as well as whatrights are conferred on the buyer.10. Rational buyersa. Buyers are capable of making rational purchases based on information given.11. No externalitiesa. Costs or benefits of an activity do not affect third parties.In the short run, perfectly competitive markets are not productively efficient as output willnot occur where marginal cost is equal to average cost (MC = AC). They are allocativelyefficient, as output will always occur where marginal cost is equal to marginal revenue (MC =MR). In the long run, perfectly competitive markets are both allocatively and productivelyefficient.In perfect competition, any profit-maximizing producer faces a market price equal to itsmarginal cost (P = MC). This implies that a factor's price equals the factor's marginal revenueproduct. It allows for derivation of the supply curve on which the neoclassical approach isbased. This is also the reason why "a monopoly does not have a supply curve". Theabandonment of price taking creates considerable difficulties for the demonstration of ageneral equilibrium except under other, very specific conditions such as that of monopolisticcompetition.

In the short run, it is possible for an individual firm to make an economic profit. Thissituation is shown in this diagram, as the price or average revenue, denoted by P, is above theaverage cost denoted by C

However, in the long run, economic profit cannot be sustained. The arrival of new firms orexpansion of existing firms (if returns to scale are constant) in the market causes the(horizontal) demand curve of each individual firm to shift downward, bringing down at thesame time the price, the average revenue and marginal revenue curve. The final outcome isthat, in the long run, the firm will make only normal profit (zero economic profit). Itshorizontal demand curve will touch its average total cost curve at its lowest point. (See costcurve.)In a perfectly competitive market, a firm's demand curve is perfectly elastic.As mentioned above, the perfect competition model, if interpreted as applying also to shortperiod or very-short-period behaviour, is approximated only by markets of homogeneousproducts produced and purchased by very many sellers and buyers, usually organized marketsfor agricultural products or raw materials. In real-world markets, assumptions such as perfectinformation cannot be verified and are only approximated in organized double-auctionmarkets where most agents wait and observe the behaviour of prices before deciding toexchange (but in the long-period interpretation perfect information is not necessary, theanalysis only aims at determining the average around which market prices gravitate, and forgravitation to operate one does not need perfect information).In the absence of externalities and public goods, perfectly competitive equilibria are Paretoefficient, i.e. no improvement in the utility of a consumer is possible without a worsening ofthe utility of some other consumer. This is called the First Theorem of Welfare Economics.The basic reason is that no productive factor with a non-zero marginal product is leftunutilized, and the units of each factor are so allocated as to yield the same indirect marginal4

utility in all uses, a basic efficiency condition (if this indirect marginal utility were higher inone use than in other ones, a Pareto improvement could be achieved by transferring a smallamount of the factor to the use where it yields a higher marginal utility).MONOPOLYA monopoly is distinguished from a monopsony, in which there is only one buyer of aproduct or service; a monopoly may also have monopsony control of a sector of a market.Likewise, a monopoly should be distinguished from a cartel (a form of oligopoly), in whichseveral providers act together to coordinate services, prices or sale of goods. Monopolies,monopsonies and oligopolies are all situations such that one or a few of the entities havemarket power and therefore interact with their customers (monopoly), suppliers (monopsony)and the other companies (oligopoly) in ways that leave market interactions distorted.Monopolies can be established by a government, form naturally, or form by integration.In many jurisdictions, competition laws restrict monopolies. Holding a dominant position or amonopoly of a market is often not illegal in itself, however certain categories of behavior canbe considered abusive and therefore incur legal sanctions when business is dominant. Agovernment-granted monopoly or legal monopoly, by contrast, is sanctioned by the state,often to provide an incentive to invest in a risky venture or enrich a domestic interest group.Patents, copyright, and trademarks are sometimes used as examples of government grantedmonopolies. The government may also reserve the venture for itself, thus forming agovernment monopoly.Market structuresIn economics, the idea of monopoly will be important for the study of managementstructures, which directly concerns normative aspects of economic competition, and providesthe basis for topics such as industrial organization and economics of regulation. There arefour basic types of market structures by traditional economic analysis: perfect competition,monopolistic competition, oligopoly and monopoly. A monopoly is a structure in which asingle supplier produces and sells a given product. If there is a single seller in a certainindustry and there are not any close substitutes for the product, then the market structure isthat of a "pure monopoly". Sometimes, there are many sellers in an industry and/or there existmany close substitutes for the goods being produced, but nevertheless companies retain somemarket power. This is termed monopolistic competition, whereas in oligopoly the companiesinteract strategically.In general, the main results from this theory compare price-fixing methods across marketstructures, analyze the effect of a certain structure on welfare, and vary technological/demandassumptions in order to assess the consequences for an abstract model of society. Mosteconomic textbooks follow the practice of carefully explaining the perfect competition model,mainly because of its usefulness to understand "departures" from it (the so-called imperfectcompetition models).CharacteristicsProfit Maximizer: Maximizes profits.1.

Price Maker: Decides the price of the good or product to be sold, but does so bydetermining the quantity in order to demand the price desired by the firm.5

2.

High Barriers: Other sellers are unable to enter the market of the monopoly.

3.

Single seller: In a monopoly, there is one seller of the good that produces all theoutput. Therefore, the whole market is being served by a single company, and forpractical purposes, the company is the same as the industry.

4.

Price Discrimination: A monopolist can change the price and quality of the product.He or she sells higher quantities, charging a lower price for the product, in a veryelastic market and sells lower quantities, charging a higher price, in a less elasticmarket.

Sources of monopoly power

Monopolies derive their market power from barriers to entry circumstances that prevent orgreatly impede a potential competitor's ability to compete in a market. There are three majortypes of barriers to entry: economic, legal and deliberate.

Economies of scale: Monopolies are characterised by decreasing costs for a relatively

large range of production. Decreasing costs coupled with large initial costs givemonopolies an advantage over would-be competitors. Monopolies are often in aposition to reduce prices below a new entrant's operating costs and thereby preventthem from continuing to compete. Furthermore, the size of the industry relative to theminimum efficient scale may limit the number of companies that can effectivelycompete within the industry. If for example the industry is large enough to supportone company of minimum efficient scale then other companies entering the industrywill operate at a size that is less than MES, meaning that these companies cannotproduce at an average cost that is competitive with the dominant company. Finally, iflong-term average cost is constantly decreasing, the least cost method to provide agood or service is by a single company.

Capital requirements: Production processes that require large investments of capital,

or large research and development costs or substantial sunk costs limit the number ofcompanies in an industry. Large fixed costs also make it difficult for a small companyto enter an industry and expand.

Technological superiority: A monopoly may be better able to acquire, integrate and

use the best possible technology in producing its goods while entrants do not have thesize or finances to use the best available technology. One large company cansometimes produce goods cheaper than several small companies.

No substitute goods: A monopoly sells a good for which there is no close substitute.The absence of substitutes makes the demand for the good relatively inelasticenabling monopolies to extract positive profits.

Control of natural resources: A prime source of monopoly power is the control of

resources that are critical to the production of a final good.

Network externalities: The use of a product by a person can affect the value of thatproduct to other people. This is the network effect. There is a direct relationshipbetween the proportion of people using a product and the demand for that product. Inother words the more people who are using a product the greater the probability ofany individual starting to use the product. This effect accounts for fads, fashiontrends, social networks etc. It also can play a crucial role in the development oracquisition of market power. The most famous current example is the marketdominance of the Microsoft office suite and operating system in personal computers.

Legal barriers: Legal rights can provide opportunity to monopolise the market of agood. Intellectual property rights, including patents and copyrights, give a monopolistexclusive control of the production and selling of certain goods. Property rights maygive a company exclusive control of the materials necessary to produce a good.

Deliberate actions: A company wanting to monopolise a market may engage in

In addition to barriers to entry and competition, barriers to exit may be a source of marketpower. Barriers to exit are market conditions that make it difficult or expensive for acompany to end its involvement with a market. Great liquidation costs are a primary barrierfor exiting. Market exit and shutdown are separate events. The decision whether to shut downor operate is not affected by exit barriers. A company will shut down if price falls belowminimum average variable costs.Monopoly Versus Competitive MarketsWhile monopoly and perfect competition mark the extremes of market structures there issome similarity. The cost functions are the same. Both monopolies and perfectly competitive(PC) companies minimize cost and maximize profit. The shutdown decisions are the same.Both are assumed to have perfectly competitive factors markets. There are distinctions, someof the more important of which are as follows:

Marginal revenue and price: In a perfectly competitive market, price equals marginalcost. In a monopolistic market, however, price is set above marginal cost.

Product differentiation: There is zero product differentiation in a perfectly competitive

market. Every product is perfectly homogeneous and a perfect substitute for any other.With a monopoly, there is great to absolute product differentiation in the sense thatthere is no available substitute for a monopolized good. The monopolist is the solesupplier of the good in question. A customer either buys from the monopolizing entityon its terms or does without.

Number of competitors: PC markets are populated by an infinite number of buyers

and sellers. Monopoly involves a single seller.

Barriers to Entry: Barriers to entry are factors and circumstances that prevent entryinto market by would-be competitors and limit new companies from operating andexpanding within the market. PC markets have free entry and exit. There are nobarriers to entry, or exit competition. Monopolies have relatively high barriers to7

entry. The barriers must be strong enough to prevent or discourage any potentialcompetitor from entering the market.

Elasticity of Demand: The price elasticity of demand is the percentage change of

demand caused by a one percent change of relative price. A successful monopolywould have a relatively inelastic demand curve. A low coefficient of elasticity isindicative of effective barriers to entry. A PC company has a perfectly elastic demandcurve. The coefficient of elasticity for a perfectly competitive demand curve isinfinite.

Excess Profits: Excess or positive profits are profit more than the normal expectedreturn on investment. A PC company can make excess profits in the short term butexcess profits attract competitors, which can enter the market freely and decreaseprices, eventually reducing excess profits to zero. A monopoly can preserve excessprofits because barriers to entry prevent competitors from entering the market

Profit Maximization: A PC company maximizes profits by producing such that price

equals marginal costs. A monopoly maximises profits by producing where marginalrevenue equals marginal costs. The rules are not equivalent. The demand curve for aPC company is perfectly elastic flat. The demand curve is identical to the averagerevenue curve and the price line. Since the average revenue curve is constant themarginal revenue curve is also constant and equals the demand curve, Averagerevenue is the same as price (AR = TR/Q = P x Q/Q = P). Thus the price line is alsoidentical to the demand curve. In sum, D = AR = MR = P.

P-Max quantity, price and profit: If a monopolist obtains control of a formerly

Supply Curve: in a perfectly competitive market there is a well-defined supply

function with a one to one relationship between price and quantity supplied. In amonopolistic market no such supply relationship exists. A monopolist cannot trace ashort term supply curve because for a given price there is not a unique quantitysupplied. As Pindyck and Rubenfeld note, a change in demand "can lead to changes inprices with no change in output, changes in output with no change in price orboth".Monopolies produce where marginal revenue equals marginal costs. For aspecific demand curve the supply "curve" would be the price/quantity combination atthe point where marginal revenue equals marginal cost. If the demand curve shiftedthe marginal revenue curve would shift as well and a new equilibrium and supply"point" would be established. The locus of these points would not be a supply curve inany conventional sense.

A monopolist can extract only one premium, and getting into complementary markets doesnot pay. That is, the total profits a monopolist could earn if it sought to leverage its monopolyin one market by monopolizing a complementary market are equal to the extra profits it couldearn anyway by charging more for the monopoly product itself. However, the one monopolyprofit theorem is not true if customers in the monopoly good are stranded or poorly informed,or if the tied good has high fixed costs.

A pure monopoly has the same economic rationality of perfectly competitive companies, i.e.to optimise a profit function given some constraints. By the assumptions of increasingmarginal costs, exogenous inputs' prices, and control concentrated on a single agent orentrepreneur, the optimal decision is to equate the marginal cost and marginal revenue ofproduction. Nonetheless, a pure monopoly can unlike a competitive company alter themarket price for its own convenience: a decrease of production results in a higher price. Inthe economics' jargon, it is said that pure monopolies have "a downward-sloping demand".An important consequence of such behaviour is worth noticing: typically a monopoly selectsa higher price and lesser quantity of output than a price-taking company; again, less isavailable at a higher price.The inverse elasticity ruleA monopoly chooses that price that maximizes the difference between total revenue and totalcost. The basic markup rule can be expressed as (P MC)/P = 1/PED. The markup rulesindicate that the ratio between profit margin and the price is inversely proportional to theprice elasticity of demand.The implication of the rule is that the more elastic the demand forthe product the less pricing power the monopoly has.Market powerMarket power is the ability to increase the product's price above marginal cost without losingall customers. Perfectly competitive (PC) companies have zero market power when it comesto setting prices. All companies of a PC market are price takers. The price is set by theinteraction of demand and supply at the market or aggregate level. Individual companiessimply take the price determined by the market and produce that quantity of output thatmaximizes the company's profits. If a PC company attempted to increase prices above themarket level all its customers would abandon the company and purchase at the market pricefrom other companies. A monopoly has considerable although not unlimited market power. Amonopoly has the power to set prices or quantities although not both. A monopoly is a pricemaker. The monopoly is the market and prices are set by the monopolist based on hiscircumstances and not the interaction of demand and supply. The two primary factorsdetermining monopoly market power are the company's demand curve and its cost structure.Market power is the ability to affect the terms and conditions of exchange so that the price ofa product is set by a single company (price is not imposed by the market as in perfectcompetition). Although a monopoly's market power is great it is still limited by the demandside of the market. A monopoly has a negatively sloped demand curve, not a perfectlyinelastic curve. Consequently, any price increase will result in the loss of some customers.

PRICE DISCRIMINATIONPrice discrimination allows a monopolist to increase its profit by charging higher prices foridentical goods to those who are willing or able to pay more. For example, most economictextbooks cost more in the United States than in developing countries like Ethiopia. In thiscase, the publisher is using its government-granted copyright monopoly to price discriminatebetween the generally wealthier American economics students and the generally poorerEthiopian economics students. Similarly, most patented medications cost more in the U.S.than in other countries with a (presumed) poorer customer base. Typically, a high generalprice is listed, and various market segments get varying discounts. This is an example offraming to make the process of charging some people higher prices more socially acceptable.Perfect price discrimination would allow the monopolist to charge each customer the exact9

maximum amount he would be willing to pay. This would allow the monopolist to extract allthe consumer surplus of the market. While such perfect price discrimination is a theoreticalconstruct, advances in information technology and micromarketing may bring it closer to therealm of possibilityIt is important to realize that partial price discrimination can cause some customers who areinappropriately pooled with high price customers to be excluded from the market. Forexample, a poor student in the U.S. might be excluded from purchasing an economicstextbook at the U.S. price, which the student may have been able to purchase at the Ethiopianprice'. Similarly, a wealthy student in Ethiopia may be able to or willing to buy at the U.S.price, though naturally would hide such a fact from the monopolist so as to pay the reducedthird world price. These are deadweight losses and decrease a monopolist's profits. As such,monopolists have substantial economic interest in improving their market information andmarket segmenting.There is important information for one to remember when considering the monopoly modeldiagram (and its associated conclusions) displayed here. The result that monopoly prices arehigher, and production output lesser, than a competitive company follow from a requirementthat the monopoly not charge different prices for different customers. That is, the monopoly isrestricted from engaging in price discrimination (this is termed first degree pricediscrimination, such that all customers are charged the same amount). If the monopoly werepermitted to charge individualised prices (this is termed third degree price discrimination),the quantity produced, and the price charged to the marginal customer, would be identical tothat of a competitive company, thus eliminating the deadweight loss; however, all gains fromtrade (social welfare) would accrue to the monopolist and none to the consumer. In essence,every consumer would be indifferent between (1) going completely without the product orservice and (2) being able to purchase it from the monopolist.[citation needed]As long as the price elasticity of demand for most customers is less than one in absolutevalue, it is advantageous for a company to increase its prices: it receives more money forfewer goods. With a price increase, price elasticity tends to increase, and in the optimum caseabove it will be greater than one for most customers.A company maximizes profit by selling where marginal revenue equals marginal cost. Acompany that does not engage in price discrimination will charge the profit maximizing price,P*, to all its customers. In such circumstances there are customers who would be willing topay a higher price than P* and those who will not pay P* but would buy at a lower price. Aprice discrimination strategy is to charge less price sensitive buyers a higher price and themore price sensitive buyers a lower price. Thus additional revenue is generated from twosources. The basic problem is to identify customers by their willingness to pay.The purpose of price discrimination is to transfer consumer surplus to the producer.Consumer surplus is the difference between the value of a good to a consumer and the pricethe consumer must pay in the market to purchase it. Price discrimination is not limited tomonopolies.Market power is a companys ability to increase prices without losing all its customers. Anycompany that has market power can engage in price discrimination. Perfect competition is theonly market form in which price discrimination would be impossible (a perfectly competitivecompany has a perfectly elastic demand curve and has zero market power).10

There are three forms of price discrimination. First degree price discrimination charges eachconsumer the maximum price the consumer is willing to pay. Second degree pricediscrimination involves quantity discounts. Third degree price discrimination involvesgrouping consumers according to willingness to pay as measured by their price elasticities ofdemand and charging each group a different price. Third degree price discrimination is themost prevalent type.There are three conditions that must be present for a company to engage in successful pricediscrimination. First, the company must have market power.[48] Second, the company must beable to sort customers according to their willingness to pay for the good. [49] Third, the firmmust be able to prevent resell.A company must have some degree of market power to practice price discrimination. Withoutmarket power a company cannot charge more than the market price. [50] Any market structurecharacterized by a downward sloping demand curve has market power monopoly,monopolistic competition and oligopoly.[48] The only market structure that has no marketpower is perfect competition.[50]A company wishing to practice price discrimination must be able to prevent middlemen orbrokers from acquiring the consumer surplus for themselves. The company accomplishes thisby preventing or limiting resale. Many methods are used to prevent resale. For examplepersons are required to show photographic identification and a boarding pass before boardingan airplane. Most travelers assume that this practice is strictly a matter of security. However,a primary purpose in requesting photographic identification is to confirm that the ticketpurchaser is the person about to board the airplane and not someone who has repurchased theticket from a discount buyer.The inability to prevent resale is the largest obstacle to successful price discrimination. [45]Companies have however developed numerous methods to prevent resale. For example,universities require that students show identification before entering sporting events.Governments may make it illegal to resale tickets or products. In Boston, Red Sox baseballtickets can only be resold legally to the team.The three basic forms of price discrimination are first, second and third degree pricediscrimination. In first degree price discrimination the company charges the maximum priceeach customer is willing to pay. The maximum price a consumer is willing to pay for a unit ofthe good is the reservation price. Thus for each unit the seller tries to set the price equal to theconsumers reservation price.[51] Direct information about a consumers willingness to pay israrely available. Sellers tend to rely on secondary information such as where a person lives(postal codes); for example, catalog retailers can use mail high-priced catalogs to highincome postal codes. First degree price discrimination most frequently occurs in regard toprofessional services or in transactions involving direct buyer/seller negotiations. Forexample, an accountant who has prepared a consumer's tax return has information that can beused to charge customers based on an estimate of their ability to pay.In second degree price discrimination or quantity discrimination customers are chargeddifferent prices based on how much they buy. There is a single price schedule for allconsumers but the prices vary depending on the quantity of the good bought. [55] The theory ofsecond degree price discrimination is a consumer is willing to buy only a certain quantity of agood at a given price. Companies know that consumers willingness to buy decreases as more11

units are purchased. The task for the seller is to identify these price points and to reduce theprice once one is reached in the hope that a reduced price will trigger additional purchasesfrom the consumer. For example, sell in unit blocks rather than individual units.In third degree price discrimination or multi-market price discrimination[56] the seller dividesthe consumers into different groups according to their willingness to pay as measured by theirprice elasticity of demand. Each group of consumers effectively becomes a separate marketwith its own demand curve and marginal revenue curve.[46] The firm then attempts tomaximize profits in each segment by equating MR and MC, Generally the company charges ahigher price to the group with a more price inelastic demand and a relatively lesser price tothe group with a more elastic demand. [59] Examples of third degree price discriminationabound. Airlines charge higher prices to business travelers than to vacation travelers. Thereasoning is that the demand curve for a vacation traveler is relatively elastic while thedemand curve for a business traveler is relatively inelastic. Any determinant of price elasticityof demand can be used to segment markets. For example, seniors have a more elastic demandfor movies than do young adults because they generally have more free time. Thus theaterswill offer discount tickets to seniors.[60]Classifying customerSuccessful price discrimination requires that companies separate consumers according totheir willingness to buy. Determining a customer's willingness to buy a good is difficult.Asking consumers directly is fruitless: consumers don't know, and to the extent they do theyare reluctant to share that information with marketers. The two main methods for determiningwillingness to buy are observation of personal characteristics and consumer actions. As notedinformation about where a person lives (postal codes), how the person dresses, what kind ofcar he or she drives, occupation, and income and spending patterns can be helpful inclassifying.[citation needed]Monopoly and efficiency

Surpluses and deadweight loss created by monopoly price setting

The price of monopoly is upon every occasion the highest which can be got. The naturalprice, or the price of free competition, on the contrary, is the lowest which can be taken, notupon every occasion indeed, but for any considerable time together. The one is upon everyoccasion the highest which can be squeezed out of the buyers, or which it is supposed theywill consent to give; the other is the lowest which the sellers can commonly afford to take,and at the same time continue their business.[64]:5612

...Monopoly, besides, is a great enemy to good management.[64]:127

Adam Smith (1776), The Wealth of NationsAccording to the standard model, in which a monopolist sets a single price for all consumers,the monopolist will sell a lesser quantity of goods at a higher price than would companies byperfect competition. Because the monopolist ultimately forgoes transactions with consumerswho value the product or service more than its cost, monopoly pricing creates a deadweightloss referring to potential gains that went neither to the monopolist nor to consumers. Giventhe presence of this deadweight loss, the combined surplus (or wealth) for the monopolist andconsumers is necessarily less than the total surplus obtained by consumers by perfectcompetition. Where efficiency is defined by the total gains from trade, the monopoly settingis less efficient than perfect competition.It is often argued that monopolies tend to become less efficient and less innovative over time,becoming "complacent", because they do not have to be efficient or innovative to compete inthe marketplace. Sometimes this very loss of psychological efficiency can increase a potentialcompetitor's value enough to overcome market entry barriers, or provide incentive forresearch and investment into new alternatives. The theory of contestable markets argues thatin some circumstances (private) monopolies are forced to behave as if there were competitionbecause of the risk of losing their monopoly to new entrants. This is likely to happen when amarket's barriers to entry are low. It might also be because of the availability in the longerterm of substitutes in other markets. For example, a canal monopoly, while worth a great dealduring the late 18th century United Kingdom, was worth much less during the late 19thcentury because of the introduction of railways as a substitute.Natural monopolyA natural monopoly is a monopoly in an industry in which it is most efficient (involving thelowest long-run average cost) for production to be permanently concentrated in a single firmrather than contested competitively. This market situation gives the largest supplier in anindustry, often the first supplier in a market, an overwhelming cost advantage over otheractual and potential competitors, so a natural monopoly situation generally leads to an actualmonopoly. This tends to be the case in industries where capital costs predominate, creatingeconomies of scale that are large in relation to the size of the market, and hence creating highbarriers to entry; examples include public utilities such as water services and electricity.[1]A natural monopoly is an organization that experiences increasing returns to scale over therelevant range of output and relatively high fixed costs. [65] A natural monopoly occurs wherethe average cost of production "declines throughout the relevant range of product demand".The relevant range of product demand is where the average cost curve is below the demandcurve.[66] When this situation occurs, it is always cheaper for one large company to supply themarket than multiple smaller companies; in fact, absent government intervention in suchmarkets, will naturally evolve into a monopoly. An early market entrant that takes advantageof the cost structure and can expand rapidly can exclude smaller companies from entering andcan drive or buy out other companies. A natural monopoly suffers from the sameinefficiencies as any other monopoly. Left to its own devices, a profit-seeking naturalmonopoly will produce where marginal revenue equals marginal costs. Regulation of naturalmonopolies is problematic. Fragmenting such monopolies is by definition inefficient. The13

most frequently used methods dealing with natural monopolies are government regulationsand public ownership. Government regulation generally consists of regulatory commissionscharged with the principal duty of setting prices.[67]

To reduce prices and increase output, regulators often use average cost pricing. By averagecost pricing, the price and quantity are determined by the intersection of the average costcurve and the demand curve. This pricing scheme eliminates any positive economic profitssince price equals average cost. Average-cost pricing is not perfect. Regulators must estimateaverage costs. Companies have a reduced incentive to lower costs. Regulation of this type hasnot been limited to natural monopolies. Average-cost pricing does also have somedisadvantages. By setting price equal to the intersection of the demand curve and the averagetotal cost curve, the firm's output is allocatively inefficient as the price exceeds the marginalcost (which is the output quantity for a perfectly competitive and allocatively efficientmarket).In small countries like New Zealand, electricity transmission is a natural monopoly. Due tolarge fixed costs and a small market size, one seller can serve the entire market at thedownward-sloping section of its average cost curve.

Government-granted monopolyA government-granted monopoly (also called a "de jure monopoly") is a form of coercivemonopoly by which a government grants exclusive privilege to a private individual orcompany to be the sole provider of a commodity; potential competitors are excluded from themarket by law, regulation, or other mechanisms of government enforcement,Monopolist shutdown ruleA monopolist should shut down when price is less than average variable cost for every outputlevel in other words where the demand curve is entirely below the average variable costcurve. Under these circumstances at the profit maximum level of output (MR = MC) averagerevenue would be less than average variable costs and the monopolists would be better offshutting down in the short term.Breaking up monopoliesWhen monopolies are not ended by the open market; sometimes a government will eitherregulate the monopoly, convert it into a publicly owned monopoly environment, or forciblyfragment it (see Antitrust law and trust busting). Public utilities, often being naturallyefficient with only one operator and therefore less susceptible to efficient breakup, are oftenstrongly regulated or publicly owned. American Telephone & Telegraph (AT&T) andStandard Oil are debatable examples of the breakup of a private monopoly by government:When AT&T, a monopoly previously protected by force of law, was broken up into variouscomponents in 1984, MCI, Sprint, and other companies were able to compete effectively inthe long distance phone market.[citation needed]

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LawThe existence of a very high market share does not always mean consumers are payingexcessive prices since the threat of new entrants to the market can restrain a high-marketshare company's price increases. Competition law does not make merely having a monopolyillegal, but rather abusing the power a monopoly may confer, for instance throughexclusionary practices (i.e. pricing high just because you are the only one around.) It mayalso be noted that it is illegal to try to obtain a monopoly, by practices of buying out thecompetition, or equal practices. If one occurs naturally, such as a competitor going out ofbusiness, or lack of competition, it is not illegal until such time as the monopoly holderabuses the power.Despite wide agreement that the above constitute abusive practices, there is some debateabout whether there needs to be a causal connection between the dominant position of acompany and its actual abusive conduct. Furthermore, there has been some consideration ofwhat happens when a company merely attempts to abuse its dominant position.MONOPOLIES OF RESOURCESSaltVending of common salt (sodium chloride) was historically a natural monopoly. Untilrecently, a combination of strong sunshine and low humidity or an extension of peat marsheswas necessary for producing salt from the sea, the most plentiful source. Changing sea levelsperiodically caused salt "famines" and communities were forced to depend upon those whocontrolled the scarce inland mines and salt springs, which were often in hostile areas (e.g. theSahara desert) requiring well-organised security for transport, storage, and distribution.The Salt Commission was a legal monopoly in China. Formed in 758, the Commissioncontrolled salt production and sales in order to raise tax revenue for the Tang Dynasty.The "Gabelle" was a notoriously high tax levied upon salt in the Kingdom of France. Themuch-hated levy had a role in the beginning of the French Revolution, when strict legalcontrols specified who was allowed to sell and distribute salt. First instituted in 1286, theGabelle was not permanently abolished until 1945.[81]CoalRobin Gollan argues in The Coalminers of New South Wales that anti-competitive practicesdeveloped in the coal industry of Australia's Newcastle as a result of the business cycle. Themonopoly was generated by formal meetings of the local management of coal companiesagreeing to fix a minimum price for sale at dock. This collusion was known as "The Vend".The Vend ended and was reformed repeatedly during the late 19th century, ending byrecession in the business cycle. "The Vend" was able to maintain its monopoly due to tradeunion assistance, and material advantages (primarily coal geography). During the early 20thcentury, as a result of comparable monopolistic practices in the Australian coastal shippingbusiness, the Vend developed as an informal and illegal collusion between the steamshipowners and the coal industry, eventually resulting in the High Court case Adelaide SteamshipCo. Ltd v. R. & AG.[82]PetroleumStandard Oil was an American oil producing, transporting, refining, and marketing company.Established in 1870, it became the largest oil refiner in the world. [83] John D. Rockefeller wasa founder, chairman and major shareholder. The company was an innovator in the15

development of the business trust. The Standard Oil trust streamlined production andlogistics, lowered costs, and undercut competitors. "Trust-busting" critics accused StandardOil of using aggressive pricing to destroy competitors and form a monopoly that threatenedconsumers. Its controversial history as one of the world's first and largest multinationalcorporations ended in 1911, when the United States Supreme Court ruled that Standard wasan illegal monopoly. The Standard Oil trust was dissolved into 33 smaller companies; two ofits surviving "child" companies are ExxonMobil and the Chevron Corporation.DiamondsDe Beers settled charges of price fixing in the diamond trade in the 2000s. De Beers is wellknown for its monopoloid practices throughout the 20th century, whereby it used its dominantposition to manipulate the international diamond market. The company used several methodsto exercise this control over the market. Firstly, it convinced independent producers to join itssingle channel monopoly, it flooded the market with diamonds similar to those of producerswho refused to join the cartel, and lastly, it purchased and stockpiled diamonds produced byother manufacturers in order to control prices through limiting supply.In 2000, the De Beers business model changed due to factors such as the decision byproducers in Russia, Canada and Australia to distribute diamonds outside the De Beerschannel, as well as rising awareness of blood diamonds that forced De Beers to "avoid therisk of bad publicity" by limiting sales to its own mined products. De Beers' market share byvalue fell from as high as 90% in the 1980s to less than 40% in 2012, having resulted in amore fragmented diamond market with more transparency and greater liquidity.In November 2011 the Oppenheimer family announced its intention to sell the entirety of its40% stake in De Beers to Anglo American plc thereby increasing Anglo American'sownership of the company to 85%.[30] The transaction was worth 3.2 billion ($5.1 billion)in cash and ended the Oppenheimer dynasty's 80-year ownership of De Beers.UtilitiesA public utility (or simply "utility") is an organization or company that maintains theinfrastructure for a public service or provides a set of services for public consumption.Common examples of utilities are electricity, natural gas, water, sewage, cable television, andtelephone. In the United States, public utilities are often natural monopolies because theinfrastructure required to produce and deliver a product such as electricity or water is veryexpensive to build and maintain.DUOPOLYA true duopoly (from Greek duo (two) + polein (to sell)) is a specific type ofoligopoly where only two producers exist in one market. In reality, this definition is generallyused where only two firms have dominant control over a market. In the field of industrialorganization, it is the most commonly studied form of oligopoly due to its simplicity.Duopoly models in economicsThere are two principal duopoly models, Cournot duopoly and Bertrand duopoly:

The Cournot model, which shows that two firms assume each other's output and treatthis as a fixed amount, and produce in their own firm according to this.16

The Bertrand model, in which, in a game of two firms, each one of them will assumethat the other will not change prices in response to its price cuts. When both firms usethis logic, they will reach a Nash equilibrium.

An example would be Pav Pooni with Chandni Chowk in the infamous Gulaab Jamun

PoliticsTwo-party systemModern American politics, in particular the electoral college system has been described asduopolistic since the Republican and Democratic parties have dominated and framed policydebate as well as the public discourse on matters of national concern for about a century anda half. Third Parties have encountered various blocks in getting onto ballots at different levelsof government as well as other electoral obstacles, more so in recent decades.Examples in business[edit]The most commonly cited duopoly is that between Visa and Mastercard, who between themcontrol a large proportion of the electronic payment processing market. In 2000 they were thedefendants in a US Department of Justice antitrust lawsuit.[1][2] An appeal was upheld in 2004.[3]

Examples where two companies control a large proportion of a market are:

MONOPOLISTIC COMPETITIONMonopolistic competition is a type of imperfect competition such that many producers sellproducts that are differentiated from one another (e.g. by branding or quality) and hence arenot perfect substitutes. In monopolistic competition, a firm takes the prices charged by itsrivals as given and ignores the impact of its own prices on the prices of other firms. [1][2] In thepresence of coercive government, monopolistic competition will fall into government-grantedmonopoly. Unlike perfect competition, the firm maintains spare capacity. Models ofmonopolistic competition are often used to model industries. Textbook examples of industrieswith market structures similar to monopolistic competition include restaurants, cereal,clothing, shoes, and service industries in large cities. The "founding father" of the theory ofmonopolistic competition is Edward Hastings Chamberlin, who wrote a pioneering book onthe subject, Theory of Monopolistic Competition (1933).[3] Joan Robinson published a bookThe Economics of Imperfect Competition with a comparable theme of distinguishing perfectfrom imperfect competition.Monopolistically competitive markets have the following characteristics:

There are many producers and many consumers in the market, and no business hastotal control over the market price.Consumers perceive that there are non-price differences among the competitors'products.There are few barriers to entry and exit.[4]Producers have a degree of control over price.

The long-run characteristics of a monopolistically competitive market are almost the same asa perfectly competitive market. Two differences between the two are that monopolistic17

competition produces heterogeneous products and that monopolistic competition involves a

great deal of non-price competition, which is based on subtle product differentiation. A firmmaking profits in the short run will nonetheless only break even in the long run becausedemand will decrease and average total cost will increase. This means in the long run, amonopolistically competitive firm will make zero economic profit. This illustrates the amountof influence the firm has over the market; because of brand loyalty, it can raise its priceswithout losing all of its customers. This means that an individual firm's demand curve isdownward sloping, in contrast to perfect competition, which has a perfectly elastic demandschedule.Major CharacteristicsThere are six characteristics of monopolistic competition (MC):

Product differentiationMany firmsNo entry and exit cost in the long runIndependent decision makingSome degree of market powerBuyers and Sellers do not have perfect information (Imperfect Information)[5][6]

Product differentiationMC firms sell products that have real or perceived non-price differences. However, thedifferences are not so great as to eliminate other goods as substitutes. Technically, the crossprice elasticity of demand between goods in such a market is positive. In fact, the XED wouldbe high.[7] MC goods are best described as close but imperfect substitutes.[7] The goodsperform the same basic functions but have differences in qualities such as type, style, quality,reputation, appearance, and location that tend to distinguish them from each other. Forexample, the basic function of motor vehicles is the sameto move people and objects frompoint to point in reasonable comfort and safety. Yet there are many different types of motorvehicles such as motor scooters, motor cycles, trucks and cars, and many variations evenwithin these categories.Many firmsThere are many firms in each MC product group and many firms on the side lines prepared toenter the market. A product group is a "collection of similar products". [8] The fact that thereare "many firms" gives each MC firm the freedom to set prices without engaging in strategicdecision making regarding the prices of other firms and each firm's actions have a negligibleimpact on the market. For example, a firm could cut prices and increase sales without fearthat its actions will prompt retaliatory responses from competitors.How many firms will an MC market structure support at market equilibrium? The answerdepends on factors such as fixed costs, economies of scale and the degree of productdifferentiation. For example, the higher the fixed costs, the fewer firms the market will18

support. Also the greater the degree of product differentiationthe more the firm canseparate itself from the packthe fewer firms there will be at market equilibrium.No entry and exit costsIn the long run there are no entry and exit costs. There are numerous firms waiting to enterthe market, each with their own "unique" product or in pursuit of positive profits. Any firmunable to cover its costs can leave the market without incurring liquidation costs. Thisassumption implies that there are low startup costs, no sunk costs and no exit costs.Independent decision makingEach MC firm independently sets the terms of exchange for its product. The firm gives noconsideration to what effect its decision may have on competitors. The theory is that anyaction will have such a negligible effect on the overall market demand that an MC firm canact without fear of prompting heightened competition. In other words each firm feels free toset prices as if it were a monopoly rather than an oligopoly.Market powerMC firms have some degree of market power. Market power means that the firm has controlover the terms and conditions of exchange. An MC firm can raise its prices without losing allits customers. The firm can also lower prices without triggering a potentially ruinous pricewar with competitors. The source of an MC firm's market power is not barriers to entry sincethey are low. Rather, an MC firm has market power because it has relatively few competitors,those competitors do not engage in strategic decision making and the firms sells differentiatedproduct. Market power also means that an MC firm faces a downward sloping demand curve.The demand curve is highly elastic although not "flat".Imperfect informationNo sellers or buyers have complete market information, like market demand or marketsupply

Inefficiency[edit]There are two sources of inefficiency in the MC market structure. First, at its optimum outputthe firm charges a price that exceeds marginal costs, The MC firm maximizes profits wheremarginal revenue = marginal cost. Since the MC firm's demand curve is downward slopingthis means that the firm will be charging a price that exceeds marginal costs. The monopolypower possessed by a MC firm means that at its profit maximizing level of production therewill be a net loss of consumer (and producer) surplus. The second source of inefficiency isthe fact that MC firms operate with excess capacity. That is, the MC firm's profit maximizingoutput is less than the output associated with minimum average cost. Both a PC and MC firmwill operate at a point where demand or price equals average cost. For a PC firm thisequilibrium condition occurs where the perfectly elastic demand curve equals minimumaverage cost. A MC firms demand curve is not flat but is downward sloping. Thus in the longrun the demand curve will be tangential to the long run average cost curve at a point to theleft of its minimum. The result is excess capacity.[19]Socially undesirable aspects compared to perfect competition Selling costs: Products under monopolistic competition are spending huge amounts onadvertising and publicity. Much of this expenditure is wasteful from the social pointof view. The producer can reduce the price of the product instead of spending onpublicity. Excess Capacity: Under Imperfect competition, the installed capacity of every firm islarge, but not fully utilized. Total output is, therefore, less than the output which issocially desirable. Since production capacity is not fully utilized, the resources lieidle. Therefore the production under monopolistic competition is below the fullcapacity level. Unemployment: Idle capacity under monopolistic competition expenditure leads tounemployment. In particular, unemployment of workers leads to poverty and miseryin the society. If idle capacity is fully used, the problem of unemployment can besolved to some extent. Cross Transport: Under monopolistic competition expenditure is incurred on crosstransportation. If the goods are sold locally, wasteful expenditure on cross transportcould be avoided. Lack of Specialization: Under monopolistic competition, there is little scope forspecialization or standardization. Product differentiation practiced under thiscompetition leads to wasteful expenditure. It is argued that instead of producing toomany similar products, only a few standardized products may be produced. Thiswould ensure better allocation of resources and would promote economic welfare ofthe society. Inefficiency: Under perfect competition, an inefficient firm is thrown out of theindustry. But under monopolistic competition inefficient firms continue to survive.

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ProblemsMonopolistically competitive firms are inefficient, it is usually the case that the costs ofregulating prices for products sold in monopolistic competition exceed the benefits of suchregulation.[citation needed] . A monopolistically competitive firm might be said to be marginallyinefficient because the firm produces at an output where average total cost is not a minimum.A monopolistically competitive market is productively inefficient market structure becausemarginal cost is less than price in the long run. Monopolistically competitive markets are alsoallocatively inefficient, as the price given is higher than Marginal cost. Product differentiationincreases total utility by better meeting people's wants than homogenous products in aperfectly competitive market.[citation needed]

Another concern is that monopolistic competition fosters advertising and the creation ofbrand names. Advertising induces customers into spending more on products because of thename associated with them rather than because of rational factors. Defenders of advertisingdispute this, arguing that brand names can represent a guarantee of quality and thatadvertising helps reduce the cost to consumers of weighing the tradeoffs of numerouscompeting brands. There are unique information and information processing costs associatedwith selecting a brand in a monopolistically competitive environment. In a monopoly market,the consumer is faced with a single brand, making information gathering relativelyinexpensive. In a perfectly competitive industry, the consumer is faced with many brands, butbecause the brands are virtually identical information gathering is also relatively inexpensive.In a monopolistically competitive market, the consumer must collect and process informationon a large number of different brands to be able to select the best of them. In many cases, thecost of gathering information necessary to selecting the best brand can exceed the benefit ofconsuming the best brand instead of a randomly selected brand. The result is that theconsumer is confused. Some brands gain prestige value and can extract an additional price forthat.Evidence suggests that consumers use information obtained from advertising not only toassess the single brand advertised, but also to infer the possible existence of brands that theconsumer has, heretofore, not observed, as well as to infer consumer satisfaction with brandssimilar to the advertised brand.[20]ExamplesIn many markets, such as toothpastes and toilet paper, producers practice productdifferentiation by altering the physical composition of products, using special packaging, orsimply claiming to have superior products based on brand images or advertising

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Short-run equilibrium of the firm under monopolistic competition. The firm maximizes itsprofits and produces a quantity where the firm's marginal revenue (MR) is equal to itsmarginal cost (MC). The firm is able to collect a price based on the average revenue (AR)curve. The difference between the firm's average revenue and average cost, multiplied by thequantity sold (Qs), gives the total profit.

Long-run equilibrium of the firm under monopolistic competition. The firm still produceswhere marginal cost and marginal revenue are equal; however, the demand curve (and AR)has shifted as other firms entered the market and increased competition. The firm no longersells its goods above average cost and can no longer claim an economic profit

MONOPSONYIn economics, a monopsony is a market form in which only one buyer interfaces withwould-be sellers of a particular product.The microeconomic theory of imperfect competition assumes the monopsonist can dictateterms to its suppliers, as the only purchaser of a good or service, much in the same mannerthat a monopolist is said to control the market for its buyers in a monopoly, in which only oneseller faces many buyers.In addition to its use in microeconomic theory, monopsony and monopsonist are descriptiveterms often used to describe a market where a single buyer substantially controls the market22

as the major purchaser of goods and services. Examples include the military industry,[1] spaceindustry,[2] and the prison industry.[3]OverviewThe term "monopsony power", in a manner similar to "monopoly power", is used byeconomists as a shorthand reference to buyers who face an upwardly sloping supply curve butthat are not the only consumer; alternative terms are oligopsony or monopsonisticcompetition.Static monopsony in a labor market

A monopsonist employer maximizes profits with employment L, that equates demand, givenby the marginal revenue product (MRP) curve, to marginal cost MC, at point A. The wage isthen determined on the supply curve, at point M, and is equal to w. By contrast, a competitivelabor market would reach equilibrium at point C, where supply S equals demand. This wouldlead to employment L' and wage w'.The standard, textbook monopsony model refers to static, partial equilibrium in a labormarket with just one employer who pays the same wage to all its workers. This modelassumes that the employer is a firm facing an upward-sloping labor supply curve (asgenerally contrasted with an infinitely elastic labor supply curve), represented by the S bluecurve in the diagram on the right. This curve relates the wage paid, , to the level ofemployment,given by

, and is denoted as the increasing function

. Total labor costs are then

. Assume now that the firm has a total revenue

according to the concave function

, which are given by:

. The firm wants to choose

.This leads to the first-order condition:

Start solving the derivative of the right hand side with the sum rule:

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, which increases with

to maximize profits,

Use the Product rule :

g=L:

Since :

on the right hand side where f=w(L) and

Maximum profits,, occurs where, since that is where a local maximum ofthe profit curve occurs, so set left hand side equal to 0:

Subtracting to put all R terms on one side and all w terms on the other:

Multiply both sides by -1:

The left-hand side of this expression,

, is the marginal revenue product of labor(roughly, the extra revenue produced by an extra worker) and is represented by the red MRPcurve in the diagram. The right-hand side is the marginal cost of labor (roughly, the extra costdue to an extra worker) and is represented by the green MC curve in the diagram. It should benoticed that this marginal cost is higher than the wageamount

paid to the new worker by the

.This is because the firm has to increase the wage paid to all the workers it already employswhenever it hires an extra worker. In the diagram, this leads to an MC curve that is above thesupply curve S.The first-order condition for maximum profit is then satisfied at point A of the diagram,where the MC and MRP curves intersect. This determines the profit-maximising employmentas L on the horizontal axis. The corresponding wage w is then obtained from the supplycurve, through point M.The monopsonistic equilibrium at M should now be contrasted with the equilibrium thatwould obtain under competitive conditions. Suppose a competitor employer entered themarket and offered a wage higher than that at M. Then every employee of the first employerwould choose instead to work for the competitor. Moreover, the competitor would gain all theformer profits of the first employer, minus a less-than-offsetting amount from the wageincrease of the first employer's employees, plus profits arising from additional employeeswho decided to work in the market because of the wage increase. But the first employerwould respond by offering an even higher wage, poaching the new rival's employees, and soforth. In other words, a group of perfectly competitive firms would be forced, throughcompetition, to intersection C rather than M. Just as a monopoly is thwarted by thecompetition to win sales, minimizing prices and maximizing output, competition for24

employees between the employers in this case would maximize both wages and employment,as shown in the graph.Welfare implications[edit]

The grey rectangle is a measure of the amount of economic welfare transferred from theworkers to their employer(s) by monopsony power. The yellow triangle shows the overalldeadweight loss inflicted on both groups by the monopsonistic restriction of employment. Itis thus a measure of the market failure caused by monopsony.The lower employment and wages caused by monopsony power have two distinct effects onthe economic welfare of the people involved. First, it redistributes welfare away fromworkers and to their employer(s). Secondly, it reduces the aggregate (or social) welfareenjoyed by both groups taken together, as the employers' net gain is smaller than the lossinflicted on workers.The diagram on the right illustrates both effects, using the standard approach based on thenotion of economic surplus. According to this notion, the workers' economic surplus (or netgain from the exchange) is given by the area between the S curve and the horizontal linecorresponding to the wage, up to the employment level. Similarly, the employers' surplus isthe area between the horizontal line corresponding to the wage and the MRP curve, up to theemployment level. The social surplus is then the sum of these two areas.Following such definitions, the grey rectangle, in the diagram, is the part of the competitivesocial surplus that has been redistributed from the workers to their employer(s) undermonopsony. By contrast, the yellow triangle is the part of the competitive social surplus thathas been lost by both parties, as a result of the monopsonistic restriction of employment. Thisis a net social loss and is called deadweight loss. It is a measure of the market failure causedby monopsony power, through a wasteful misallocation of resources.As the diagram suggests, the size of both effects increases with the difference between themarginal revenue product MRP and the market wage determined on the supply curve S. Thisdifference corresponds to the vertical side of the yellow triangle, and can be expressed as aproportion of the market wage, according to the formula:

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.The ratio has been called the rate of exploitation, and it can be easily shown that it equalsthe reciprocal of the elasticity of the labour supply curve faced by the firm. Thus the rate ofexploitation is zero under competitive conditions, when this elasticity tends to infinity.Empirical estimates of by various means are a common feature of the applied literaturedevoted to the measurement of observed monopsony power.Finally, it is important to notice that, while the gray-area redistribution effect could bereversed by fiscal policy (i.e., taxing employers and transferring the tax revenue to theworkers), this is not so for the yellow-area deadweight loss. The market failure can only beaddressed in one of two ways: either by breaking up the monopsony through anti-trustintervention, or by regulating the wage policy of firms. The most common kind of regulationis a binding minimum wage higher than the monopsonistic wage.Minimum wage[edit]

With a binding minimum wage of w'' the marginal cost to the firm becomes the horizontalblack MC' line, and the firm maximises profits at A with a higher employment L''. Howeverin this example, the minimum wage is higher than the competitive one, leading to involuntaryunemployment equal to the segment AB.A binding minimum wage can be introduced either by law or through collective bargaining,and its possible effects in a special case are shown in the diagram on the right.Here the minimum wage is w'', higher than the monopsonistic w. At this given wage the firmcan now hire all the workers it wants, up to the supply curve, so that in the relevantemployment range its marginal cost of labor becomes effectively constant and equal to w'',, asshown by the new black horizontal line MC'. Hence the firm maximizes profits at the newintersection point A, choosing the employment level L'', which is higher than themonopsonistic level L. As the reader can check, the rate of exploitation has been reduced tozero.More generally, a binding minimum wage modifies the form of the supply curve faced by thefirm, which becomes:26

whereis the original supply curve andis the minimum wage. The new curve hasthus a horizontal first branch and a kink at the point

as is shown in the diagram by the kinked black curve MC' S. The resulting equilibria (theprofit-maximizing choices that rational companies will make) can then fall into one of threeclasses according to the value taken by the minimum wage, as shown by the following table:Profit Maximizing Choice In A Monopsonistic Labor Market Depends Upon The MinimumWage LevelMinimum WageResulting EquilibriumFirst Case< than monopsony wage unchanged from monopsony>monopsonywageSecond Case butat kink of supply curve<= than competitive wageThird Case > competitive wageat intersection where minimum wage equals MRPAs it is now seen, the example illustrated by the diagram belongs to the third regime. As aresult, there is an excess supply of labor i.e. involuntary unemployment equal to thesegment AB. So, although the exploitation rate has vanished, there is still a deadweight loss tosociety. This illustrates the problems that may arise when the proper level of the bindingminimum wage is not exactly known, or cannot be enforced for political reasons.Yet, even when it is sub-optimal, a minimum wage higher than the market rate raises the levelof employment anyway. This is a highly remarkable result, because it only follows undermonopsony. Indeed, under competitive conditions any minimum wage higher than the marketrate would actually reduce employment, according to classical economic models. Thus,spotting the effects on employment of newly introduced minimum wage regulations is amongthe indirect ways economists use to pin down monopsony power in selected labor markets.Wage discriminationJust like a monopolist, a monopsonistic employer may find that its profits are maximized if itdiscriminates prices. In this case this means paying different wages to different groups ofworkers even if their MRP is the same, with lower wages paid to the workers who have alower elasticity of supply of their labor to the firm.Researchers have used this fact to explain at least part of the observed wage differentialswhereby women often earn less than men, even after controlling for observed productivitydifferentials. Robinson's original application of monopsony (1938) was developed to explainwage differentials between equally productive women and men. Ransom and Oaxaca (2004)found that women's wage elasticity is lower than that of men for employees at a grocery storechain in Missouri, controlling for other factors typically associated with wage determination.[12]Ransom and Lambson (2011) found that female teachers are paid less than male teachersdue to differences in labor market mobility constraints facing women and men.[13]

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Some authors have argued informally that, while this is so for market supply, the reverse maysomehow be true of the supply to individual firms. In particular, Manning and others haveshown that, in the case of the UK Equal Pay Act, implementation has led to higheremployment of women. Since the Act was effectively minimum wage legislation for women,this might perhaps be interpreted as a symptom of monopsonistic discrimination.Empirical problems[edit]The simplified dynamics sketched above suggests that the frequent observation of short-runrelative inelasticity of labour supply to individual firms may not be very relevant to thediagnosis of significant monopsony power. Efforts to measure the size of the exploitation ratein specific labour markets have hence taken various forms:

direct measurement of wage and MRP

estimates of the long-run supply elasticity of labour to firms

cross-sectional comparisons of wages and employer concentration

correlations between wages and workers' mobility

structural estimation of equilibrium search models

employment effects of minimum wages

The results of these empirical works are rarely unambiguous. However, even in cases such ascoal miners or nurses, most US studies suggest rates of exploitation probably lower thanmarginal tax rates on workers' incomes, or union relative wage effects. The betterdocumented instances of significant exploitation are found in the probably rare cases ofexplicit collusion, such as US baseball before the reserve clause.Sources of labour monopsony power[edit]The simpler explanation of monopsony power in labour markets is barriers to entry on thedemand side. In all such cases, oligopsony would result from oligopoly in the productmarkets of the industries that use that type of labour as input. If the hypothesis was generallytrue, one would then find a positive statistical correlation between exploitation, on one side,and industry concentration and firm size on the other. However, numerous statistical studiesdocument significant positive correlations between firm or establishment size and wages.These results, by themselves inconsistent with the oligopoly-oligopsony hypothesis, may bedue to the prevalence of other factors, such as efficiency wages.However, monopsony power might also be due to circumstances affecting entry of workerson the supply side, directly reducing the elasticity of labour supply to firms. Paramountamong these are moving costs for workers, which are also a cause of differentiation amongpotential employees, possibly leading to discrimination (see above). But a similar effectmight also be produced by all the institutional factors that limit labour mobility betweenfirms, including job protection legislation. The vetting of employees in the government or thedefense sector is another source of monopsonistic competition, as are requirements forprofessional certification, for example, a medical degree. Finally, as already noticed, asignificant reduction in the short-run elasticity of supply may come from information costsand search behaviour.28

An alternative that has been suggested as a source of monopsony power is worker preferencesover job characteristics (Bhaskar and To, 1999; Bhaskar, Manning and To, 2002). Such jobcharacteristics can include distance from work, type of work, location, the social environmentat work, etc. If different workers have different preferences, employers have local monopsonypower over workers that strongly prefer working for them.Finally, monopsony power will occur when the average revenue product of labor increaseswith the amount of labor employed, due to economies of scale. In this case, the perfectlycompetitive solution (workers are paid their marginal revenue product) is not stable. In thelong run, the firm may set wages equal to the average revenue product of labor, or engage inwage discrimination, paying wages closer to marginal product to markets (or workers) withhigher elasticity of supply.

OLIGOPOLYAn oligopoly is a market form in which a market or industry is dominated by a small numberof sellers (oligopolists). Oligopolies can result from various forms of collusion which reducecompetition and lead to higher prices for consumers. Oligopoly has its own market structure.[1]

With few sellers, each oligopolist is likely to be aware of the actions of the others. Accordingto game theory, the decisions of one firm therefore influence and are influenced by thedecisions of other firms. Strategic planning by oligopolists needs to take into account thelikely responses of the other market participants.DescriptionOligopoly is a common market form where a number of firms are in competition. As aquantitative description of oligopoly, the four-firm concentration ratio is often utilized. Thismeasure expresses the market share of the four largest firms in an industry as a percentage.For example, as of fourth quarter 2008, Verizon, AT&T, Sprint, and T-Mobile together control89% of the US cellular phone market.[citation needed]Oligopolistic competition can give rise to a wide range of different outcomes. In somesituations, the firms may employ restrictive trade practices (collusion, market sharing etc.) toraise prices and restrict production in much the same way as a monopoly. Where there is aformal agreement for such collusion, this is known as a cartel. A primary example of such acartel is OPEC which has a profound influence on the international price of oil.Firms often collude in an attempt to stabilize unstable markets, so as to reduce the risksinherent in these markets for investment and product development.[citation needed] There are legalrestrictions on such collusion in most countries. There does not have to be a formalagreement for collusion to take place (although for the act to be illegal there must be actualcommunication between companies)for example, in some industries there may be anacknowledged market leader which informally sets prices to which other producers respond,known as price leadership.In other situations, competition between sellers in an oligopoly can be fierce, with relativelylow prices and high production. This could lead to an efficient outcome approaching perfectcompetition. The competition in an oligopoly can be greater when there are more firms in an29

industry than if, for example, the firms were only regionally based and did not competedirectly with each other.Thus the welfare analysis of oligopolies is sensitive to the parameter values used to define themarket's structure. In particular, the level of dead weight loss is hard to measure. The study ofproduct differentiation indicates that oligopolies might also create excessive levels ofdifferentiation in order to stifle competition.Oligopoly theory makes heavy use of game theory to model the behavior of oligopolies:

CharacteristicsProfit maximization conditionsAn oligopoly maximizes profits .Ability to set priceOligopolies are price setters rather than price takers.Entry and exitBarriers to entry are high.[3] The most important barriers are government licenses,economies of scale, patents, access to expensive and complex technology, andstrategic actions by incumbent firms designed to discourage or destroy nascent firms.Additional sources of barriers to entry often result from government regulationfavoring existing firms making it difficult for new firms to enter the market.[4]Number of firms"Few" a "handful" of sellers.[3] There are so few firms that the actions of one firmcan influence the actions of the other firms.[5]Long run profitsOligopolies can retain long run abnormal profits. High barriers of entry preventsideline firms from entering market to capture excess profits.Product differentiationProduct may be homogeneous (steel) or differentiated (automobiles).[4]Perfect knowledgeAssumptions about perfect knowledge vary but the knowledge of various economicfactors can be generally described as selective. Oligopolies have perfect knowledge oftheir own cost and demand functions but their inter-firm information may beincomplete. Buyers have only imperfect knowledge as to price, [3] cost and productquality.InterdependenceThe distinctive feature of an oligopoly is interdependence.[6] Oligopolies are typicallycomposed of a few large firms. Each firm is so large that its actions affect marketconditions. Therefore the competing firms will be aware of a firm's market actionsand will respond appropriately. This means that in contemplating a market action, afirm must take into consideration the possible reactions of all competing firms and the30

firm's countermoves.[7] It is very much like a game of chess or pool in which a playermust anticipate a whole sequence of moves and countermoves in determining how toachieve his or her objectives. For example, an oligopoly considering a price reductionmay wish to estimate the likelihood that competing firms would also lower theirprices and possibly trigger a ruinous price war. Or if the firm is considering a priceincrease, it may want to know whether other firms will also increase prices or holdexisting prices constant. This high degree of interdependence and need to be aware ofwhat other firms are doing or might do is to be contrasted with lack ofinterdependence in other market structures. In a perfectly competitive (PC) marketthere is zero interdependence because no firm is large enough to affect market price.All firms in a PC market are price takers, as current market selling price can befollowed predictably to maximize short-term profits. In a monopoly, there are nocompetitors to be concerned about. In a monopolistically-competitive market, eachfirm's effects on market conditions is so negligible as to be safely ignored bycompetitors.Non-Price CompetitionOligopolies tend to compete on terms other than price. Loyalty schemes,advertisement, and product differentiation are all examples of non-price competition.OLIGOPSONYAn oligopsony is a market form in which the number of buyers is small while the number ofsellers in theory could be large. This typically happens in a market for inputs where numeroussuppliers are competing to sell their product to a small number of (often large and powerful)buyers. It contrasts with an oligopoly, where there are many buyers but few sellers. Anoligopsony is a form of imperfect competition.The terms monopoly (one seller), monopsony (one buyer), and bilateral monopoly have asimilar relationship.onemonopolymonopsony

fewoligopolyoligopsony

sellersbuyersIndustry ExamplesIn each of these cases, the buyers have a major advantage over the sellers. They can play offone supplier against another, thus lowering their costs. They can also dictate exactspecifications to suppliers, for delivery schedules, quality, and (in the case of agriculturalproducts) crop varieties. They also pass off much of the risks of overproduction, naturallosses, and variations in cyclical demand to the suppliers.AgricultureOne example of an oligopsony in the world economy is cocoa, where three firms (Cargill,Archer Daniels Midland, and Callebaut) buy the vast majority of world cocoa beanproduction, mostly from small farmers in third-world countries. Likewise, American tobaccogrowers face an oligopsony of cigarette makers, where three companies (Altria, Brown &Williamson, and Lorillard Tobacco Company) buy almost 90% of all tobacco grown in theUS and other countries.

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RetailOver at least 30 years, supermarkets in developed economies around the world have acquiredan increasing share of grocery markets. In doing so, they have increased their influence oversupplierswhat food is grown and how it is processed and packagedwith impacts reachingdeep into the lives and livelihoods of farmers and workers worldwide. In addition toincreasing their market share with consumers, consolidation of suppliers means that retailerscan exercise significant market power. In some countries, this has led to allegations of abuse,unethical and illegal conduct.The situation in Australia is a good example, with two retailers, Coles and Woolworthscontrolling 70% of the national food market